Financial Innovation and the Transactions Demand for Cash

41 Pages Posted: 18 Dec 2008

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Francesco Lippi

Università degli Studi di Sassari; Einaudi Institute for Economics and Finance (EIEF)

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Date Written: November 2008

Abstract

We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We extend the Baumol-Tobin cash inventory model to a dynamic environment that allows for the possibility of withdrawing cash at random times at a low cost. This modification introduces a precautionary motive for holding cash and naturally captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We characterize the solution of the model, which qualitatively reproduces several empirical patterns. We estimate the structural parameters using micro data, and show that quantitatively the model captures important economic patterns. The estimates are used to quantify the expenditure and interest rate elasticity of money demand, the impact of financial innovation on money demand, the welfare cost of inflation, and the benefit of ATM ownership.

Keywords: money demand, technological progress, inventory models

JEL Classification: E5

Suggested Citation

Alvarez, Fernando and Lippi, Francesco, Financial Innovation and the Transactions Demand for Cash (November 2008). Econometrica, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1316986

Fernando Alvarez

University of Chicago - Department of Economics ( email )

1126 East 59th Street
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National Bureau of Economic Research (NBER)

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Francesco Lippi (Contact Author)

Università degli Studi di Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

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